Private Equity and Hedge Funds should expect More SEC Scrutiny Ahead – Finance and banking

Private Equity and Hedge Funds should expect More SEC Scrutiny Ahead - Finance and banking

Foley & Lardner

19 November 2021

Highlights


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Fees and Expenses:  Chair Gensler
advocated for additional transparency regarding private fund fees
and expenses which he hopes will lead to greater competition. 
In particular he referenced the multiple types of fees common in
private funds, including management fees, performance fees,
portfolio company fees, consulting fees, advisory fees, monitoring
fees, servicing fees, transaction fees, director fees,
etc.—which, in his opinion, need streamlining or more
transparency.

Side Letters:  Chair Gensler advocated
for additional transparency in side letter provisions to support
more equality amongst similarly situated limited partners. 
Importantly, he suggested the SEC is considering prohibiting
certain types of side letter provisions.  In particular,
Gensler focused on side letters that result in preferred liquidity,
disclosure, and/or fee terms.  Such provisions, he noted,
result in “similar pension plans consistently pay[ing]
different private equity fees”, a fact which he believes
results in an “uneven playing field” among limited
partners in a fund—presumably a condition to be remedied by
more transparency of side letter terms.

Performance Metrics:  Chair Gensler
advocated for increased transparency regarding performance metrics,
including potentially requiring private funds to prepare
performance information matching the standardized information
already mandatory for mutual funds.  The SEC standardized and
mandated performance reporting methodology for mutual funds decades
ago, while allowing non-standard performance reporting if
accompanied by SEC measures of “total return”.

Fiduciary Duties:  Chair Gensler reminded
attendees that under no circumstances, and in no form, can general
partners contract themselves out of their federal fiduciary duties
under the Advisers Act.  There are increasing efforts by
general partners to add such provisions to fund documents.  It
was unclear if Chair Gensler intended to break new ground or was
referring to the Commission’s position on standards of conduct
(i.e., fiduciary duty cannot be waived “though its application
may be shaped by agreement”.)  See, IA-5248, footnote 31.
 https://www.sec.gov/rules/interp/2019/ia-5248.pdf.

Conflicts of Interest:  Gensler stated an
intention to mitigate the effects of conflicts of interest between
general partners, affiliates, and their investors.  He has
asked SEC staff to consider potential prohibitions on specific
conflicts and practices, but did not mention any in
particular.

Form PF:  Chair Gensler advocated for an
update to Form PF to include more granular and/or timelier
information in order to strengthen the SEC’s oversight of
private fund advisers and better understand private funds’
systemic role in the financial markets in general. 

Last week, SEC Chair Gary Gensler gave the keynote speech for
the 2021 Institutional Limited Partners Association’s virtual
summit.  Gensler focused his remarks exclusively on private
funds and detailed his view that private equity and hedge funds
need more scrutiny and regulation.  Careful to differentiate
his statements from those of the SEC, he listed the following
subjects as areas he expects will receive additional SEC focus in
the near term:

Chair Gensler framed the need for these additional regulations
as stemming from a concern for the importance of the key players in
the private funds market – (i) institutional investors,
including pension plans, foundations, and endowments, on the one
side, and (ii) portfolio companies, including start-ups, small
businesses, and more established commercial enterprises, on the
other—all of whom he believes would benefit from greater
government protection and oversight of private funds.  Gensler
elaborated:

“Private funds touch so much of our economy.  So
it is worth asking ourselves at the SEC whether we’re meeting
our mission with respect to this important slice of the capital
markets?  Are we protecting investors?  Are we
facilitating capital formation?  Are we maintaining fair,
orderly and efficient markets in the middle?”

Chair Gensler apparently believes the answer is “needs
improvement”.  We note that Chair Gensler’s reference
to standards for mutual funds seems instructive as to where the
Commission might head during his tenure. A transcript of Gensler’s entire speech can be found here.

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